The treatment of bad and doubtful debts is a critical area of tax compliance for banks. The Direct Tax Code (DTC) 2025 provides a comprehensive framework for the deduction of provisions for bad and doubtful debts, linked to the classification of non-performing assets (NPAs) as per RBI norms. This guide analyses the complete NPA classification rules for banks.
The Bad Debt Framework Under Section 31
Section 31 — Deduction for Bad Debt and Provision for Bad and Doubtful Debt
Section 31 of the DTC provides for deduction in respect of:
- Provision for bad and doubtful debts made by specified assessees (Table: Sl. No. 1)
- Bad debt written off as irrecoverable (Sub-section 2)
Section 31(1) — Deduction for Provision
The following assessees are entitled to deduction for provision for bad and doubtful debts:
| Sl. No. | Specified Assessee | Amount of Deduction |
|---|---|---|
| 1 | Scheduled bank, non-scheduled bank, co-operative bank (other than primary agricultural credit society or primary co-operative agricultural and rural development bank) | Not more than 8.5% of total income, plus additional amount up to 10% of aggregate average advances made by rural branches |
| 2 | Bank incorporated outside India, public financial institution, State Financial Corporation, State Industrial Investment Corporation, non-banking financial company | Not more than 5% of total income |
Section 31(2) — Deduction for Bad Debt Written Off
Any amount of bad debt, or part of it, in the tax year in which such amount is written off as irrecoverable in the accounts of the assessee, shall be allowed as deduction, subject to:
- It has been taken into account in computing the income of the assessee of the tax year in which it is written off, or any earlier tax year
- It represents the money lent in the ordinary course of the business of banking or money lending
Section 31(3) — Key Clarifications
- Any bad debt or part of it written off as irrecoverable shall not include any provision for bad and doubtful debt
- Any amount of bad debt which has been taken into account in computing income as per income computation and disclosure standards without recording it in the accounts shall be allowed as deduction
NPA Classification Rules for Banks
The 90-Day Overdue Test
Under RBI norms, a loan account is classified as NPA where interest and/or instalment of principal remains overdue for a period of more than 90 days.
Out of Order Accounts
An account is considered "out of order" if:
- The outstanding balance remains continuously in excess of the sanctioned limit or drawing power for 90 days; or
- The outstanding balance is less than the sanctioned limit but there are no credits continuously for 90 days
Categories of NPA
1. Sub-Standard Assets
An asset is classified as sub-standard if it has remained NPA for a period up to 12 months. Provisioning requirement: 10%.
2. Doubtful Assets
An asset is classified as doubtful if it has remained NPA for a period exceeding 12 months. Provisioning requirements:
- Up to 1 year: 20% provision
- 1 to 3 years: 30% provision
- More than 3 years: 50% provision
3. Loss Assets
An asset is classified as loss if it is considered uncollectible and has been identified as loss by the bank or the auditors. Provisioning requirement: 100%.
Tax Deduction for NPA Provisions
Allowability of Deduction
Under Section 31(1), specified banks are allowed a deduction for provisions made towards bad and doubtful debts. However:
- Provision vs. Actual Write-Off: Only the amount of any bad debt or part thereof which is written off as irrecoverable in the accounts is an allowable deduction under Section 31(2)
- NPA Provision Disallowance: Provisions for NPAs made as per RBI norms may be disallowed by tax authorities when assessing income tax liabilities
Special Provision for Interest Income
Section 56 provides that interest income in relation to bad or doubtful debts of a specified financial institution shall be chargeable to tax in the tax year in which such interest is:
- Credited to the profit and loss account; or
- Actually received, whichever is earlier
Bad Debt Deduction for Banks
Under Section 31(2), any amount of bad debt written off as irrecoverable is eligible for deduction, subject to:
- It has been taken into account in computing income
- It represents money lent in the ordinary course of business
Practical Compliance for Banks
1. Identify NPAs
- Identify NPAs as per RBI norms (90-day delinquency norm)
- Classify NPAs into sub-standard, doubtful, and loss assets
2. Make Provisions
- Make provisions for NPAs as required by RBI
- Maintain records of provisions
3. Claim Deduction for Provision
- Claim deduction for provisions under Section 31(1) (limited to 8.5% of total income, plus 10% of rural advances)
4. Write Off Bad Debts
- Write off bad debts as irrecoverable
- Maintain records of write-offs
5. Claim Deduction for Bad Debts
- Claim deduction for bad debts written off under Section 31(2)
6. Special Consideration — Rural Branches
- For scheduled banks, additional deduction up to 10% of aggregate average advances made by rural branches
Consequences of Non-Compliance
Disallowance of Deduction
If the bad debt is not properly written off or the NPA is not properly identified:
- The deduction may be disallowed
- Income may be recomputed
- Interest and penalty may be levied
Penalty
Non-compliance may result in penalty under Section 439 for under-reporting of income.
Expert Legal Guidance
Anuj Desai & Associates provides comprehensive legal advisory services on bad debt provisions and NPA classification for banks. Our direct tax experts help banks understand the NPA classification rules, claim eligible deductions, and navigate the regulatory framework. We assist in NPA identification, provision computation, and representation before income-tax authorities.
Disclaimer: This article provides general information and does not constitute legal advice. For specific guidance on bad debt provisions or any other direct tax matter, please consult qualified legal professionals.
Need Expert Legal Guidance?
Navigating the complex bad debt and NPA classification framework for banks requires experienced legal counsel. At Anuj Desai & Associates, we provide comprehensive direct tax advisory services, including:
- NPA Identification: Guidance on NPA classification
- Provision Computation: Assistance with provision computation
- Compliance: Guidance on bad debt write-off and deduction
- Representation: Representation before income-tax authorities
Contact us for expert legal guidance on your bank bad debt matters.